December 2007: Despite
increasingly stringent legislation aimed at combating fraud,
such as the Foreign Corrupt Practices Act and the
Sarbanes-Oxley Act – and despite increased enforcement efforts
by the Securities and Exchange Commission (SEC) – financial
statement fraud remains a public concern.

Just what types of fraud is the
SEC describing in its enforcement actions? In what industries
are frauds most prevalent? Have fraud types and industry
patterns changed over time?

To address these questions, and
to learn how fraud schemes have evolved since the Committee of
Sponsoring Organizations of the Treadway Commission produced
its last comprehensive report on fraud in 1999, the Deloitte
Forensic Center has, in 2007, completed an analysis of hundreds
of SEC enforcement releases issued from 2000 through 2006. (Read
more...)

November 2007: Financial
statement fraud is the most expensive type of fraud perpetrated
by an employee, with a median cost of $2 million per scheme. It
occurs the least often however, with financial statement
manipulation present in only 10% of all fraud schemes.

This type of fraud is generally
perpetrated by upper management, as they are typically the
employees with the access and the influence to manipulate
financial statements. Upper management usually has the most to
gain from financial statement fraud, from increased performance
bonuses, to more valuable stock options, to lucrative job
promotions. (Read
more...)

APRIL
2007: Prior to 2001, hardly anyone in South Africa had
heard of Enron. Indeed, even in the USA, its name was not widely
known to the general public. Yet, in 2001, Fortune Magazine ranked
it as the US's seventh largest corporation.

During the 1990s, it had grown at a phenomenal
rate. Intriguingly, if it had continued to grow at its historical
rate, it would have reached number one by now in 2007.

Since 2001, the name Enron has evolved into a
spectre that has haunted investors, regulators, the accountancy
profession and politicians worldwide.

When Enron filed for bankruptcy in December
2001, it was the largest bankruptcy case in US history. Its demise
has subsequently led to huge changes in governance and regulatory
practices around the world.

But while Enron hogged the headlines, it is well
worth noting that it was not the only collapse at the time. Indeed,
many more occurred in the US, Europe, Asia and South Africa – often
for similar reasons. Enron, however, stood out from the others
because of its size and influence.

Looking back five years on, prompts one to ask
if anything has changed; what lessons we have learned and whether
or not Enron could happen again. (

What do Enron, WorldCom, Tyco, Adelphia, Global
Crossing, Xerox, and Parmalat all have in common? They were all
considered financial statement frauds. During the past seven years,
financial statement frauds have grown dramatically in both the
number occurring and the size of the losses. Fraudulent financial
statements affect shareholders, lenders, creditors, and employees.

Consequently, many investors have lost confidence in the
credibility of financial statements 59% of class-action securities
lawsuits in US during 1997 alleged accounting abuses. This is up
from 43% in 1996. In April 1998, Business Week held its Forum of
Chief Financial Officers. During that forum, the CFOs revealed that
67% of them had been asked by senior company executives to
misrepresent the financial results of the corporation. Of those,
12% admitted that they had in fact actually misrepresented the
financial results! It is estimated that the average financial
statement fraud results in a $5,000,000 misstatement on the books.
What is financial statement fraud and why are so many people
committing it? (

The focus of this series of articles is on
creating an awareness of how financial statement fraud is committed, why it
is committed, and ways that you can help to detect and prevent it from
occurring. Part 1 created the awareness of how and why financial statement
fraud is committed. This article will provide you with an overview of a
systematic approach to investigating possible financial statement fraud. (Read
more...)

The focus of this series is on
creating an awareness of how financial statement fraud is
committed, why it is committed, and ways that you can help to
detect and prevent it from occurring. Part 1 of the series
created the awareness of how and why financial statement fraud
is committed. Part 2 provided an overview of a methodology that
could be utilized to investigate suspected cases of financial
statement fraud. This part discusses some of the most common
schemes that are used to commit financial statement fraud and
ways that they can be detected or prevented. (Read
more...)

SEPTEMBER 2006 - The
corporate financial scandals in the early part of this decade shocked our
financial markets and will be remembered for the carnage left by the likes
of Enron and WorldCom: thousands of workers robbed of their retirement
funds, millions of investors who lost their savings, and the havoc wreaked
upon our economic and social systems. If we could only put it all behind us!

JULY 2006: This is the first of two articles describing
the requirements of—and implementation suggestions for—new guidance from the
Auditing Standards Board (ASB). This article discusses the process of
assessing risks and controls, leading to the concept of the risk of material
misstatement. A subsequent JofA article will discuss how the
auditor responds to the risk of material misstatement. (Read
more...)

JULY 2006: There is no statute
that explicitly outlaws backdating stock-option grants, but it
seems virtually impossible to backdate options and achieve the
ultimate goal of putting grants "in the money" without first
deliberately falsifying documents and then covering up the
sham. At least that seems to be the conclusion reached by the
Department of Justice and the Securities and Exchange
Commission regarding their first case against executives
charged with fraud related to backdating.
(Read
more...)

MARCH 2006: CPAs typically focus on
uncovering items that would impact the reported earnings or the balance
sheet of a company. Knowing that investors use the balance sheet and the
income statement to make investment decisions, companies sometimes engage in
unusual or aggressive accounting practices in order to flatter their
reported figures, especially earnings. (Read
more...)

Financial statement fraud can
have severe consequences. In examining financial statements,
professional investigators often focus their attention on
certain red flags. By familiarizing themselves with these
common fraud techniques and indicators, management can minimize
the impact of financial statement fraud and mitigate future
risks. (Read
more...)

DECEMBER 2005: Bernard Ebbers, former Chief Executive of
WorldCom, has finally been sentenced for his role in the collapse
of WorldCom, more than two years after an internal auditor began
questioning some curious accounting.

Ebbers was found guilty of orchestrating the
$11-billion accounting fraud after his former chief financial
officer testified that Ebbers had instructed him to hide expenses
and overstate revenue in order to meet market expectations of the
telecommunications company. Although the conviction was
anticipated, the sentence was not. (

OCTOBER 2005: SAS No. 99 increases the number of red flags to 42, extensively
revises the existing indicators, and requires auditors to consider the risk
of a possible material misstatement due to fraud. One accounting Web site,
AccountingMalpractice.com, describes the change as switching auditors' focus
from "I believe management" to "I don't believe management" and strongly
hints that any auditor who fails to recognize these fraud warning signs
could be held negligent. (Read
more...)

MARCH 2005: Detection of
financial statement fraud is on the front burner. With billions
of losses behind us from such companies as Enron, Tyco, and
WorldCom, the numbers of cases has slowed but not stopped.
Catching the deeds early is important because the average
financial statement fraud costs businesses an average of $1
million, according to the ACFE's 2004 Report to the Nation.
Analysis ratios tested by an Indiana University professor show
promise in identifying possible infractions and helping CFEs
focus their efforts once retained to look into suspicions.
Although the study is now six years old, it appears to be
increasingly used to help detect signs of financial
manipulations. (Read
more...)

2005: This study investigates
whether auditors’ attitudes towards creative accounting are
associated with ethical judgement, their evaluation of the
quality of financial reporting and their perceptions of factors
that influence preparers of financial statements to use
aggressive accounting techniques. The results of this study
reveal a significant relationship between auditors’ assessments
of the relevance and reliability (but not ethical judgement) of
reported information and their attitudes to creative
accounting. Some insight is gained into auditors’ perceptions
of the factors that influence preparers to use creative
accounting in South Africa. (Read
more...)

With the host of
headline-grabbing stories dealing with financial misstatements
of high-profile U.S. companies, it is increasingly likely that
lawyers in Canada will play some role with an entity embroiled
in a financial misstatement issue. This role may be as a
director, as a business law advisor, or as a litigator. This
paper is intended to provide an introductory review of the
topic of financial misstatements and “earnings management.” (Read
more...)

OCTOBER 2004: A forensic audit
conducted by PricewaterhouseCoopers concluded that HealthSouth
Corporation's cumulative earnings were overstated by anywhere
from $3.8 billion to $4.6 billion, according to a January 2004
report issued by the scandal-ridden health-care concern.
HealthSouth acknowledged that the forensic audit discovered at
least another $1.3 billion dollar's in suspect financial
reporting in addition to the previously estimated $2.5 billion.
The scandal's postmortem report found additional fraud of $500
million, and identified at least $800 million of improper
accounting for reserves, executive bonuses, and related-party
transactions. This billion-dollar-plus admission failed to
garner financial media headlines, further evidence of the
public's inurement to financial reporting scandals. (Read
more...)

SEPTEMBER 2004: It's as predictable as anything about the stock market: when a company's
share price plunges, shareholders sue. But launching a successful
shareholder suit — that is, one that gets settled — may soon become harder.

The U.S. Supreme Court has agreed to review a decision in a case that
pits shareholders against Dura Pharmaceuticals Inc., a drug firm now owned
by Ireland-based Elan Corp. At issue is a fundamental question: When fraud
occurs and investors lose, how do you prove the link between fraud and loss?
(Read more...)

As we noted in our previous
article in the Jan./Feb. 2000 issue of The White Paper,
earnings management involves entity managers and accountants
asking “How can we best report desired results?” rather than
“How can we best report economic reality (the actual
results)?”1 When reported results are intentionally misstated,
earnings management becomes fraud. Corporate scandals including
Enron, and WorldCom, and these entities' external auditor,
Arthur Andersen, are instructive on such accounting and
business abuses. They also point to the critical need for
further involvement of fraud examiners in assuring the verity
of published financial information. (Read
more...)

JULY 2003: Over
a period of several years, the management of the Baptist
Foundation of Arizona (BFA) engaged in one of the most
audacious fraud schemes on record. BFA ultimately filed for
bankruptcy, and thousands of elderly investors lost their life
savings. How did such a massive fraud develop? What clues did
the auditors overlook? BFA's failure and the subsequent
penalties provide a sobering reminder to auditors that it is
important to understand the causes of fraud and even more
critical to engage in effective audit procedures to detect
fraud. Improving and strengthening fraud detection is at the
heart of the accounting profession's new antifraud initiatives,
such as the recently issued SAS 99, Consideration of Fraud in a
Financial Statement Audit. (Read
more...)

JUNE 2003: In
light of the accounting scandals plaguing corporate America,
board members who do not understand the increasingly complex
financial transactions that companies engage in are placing
their firms, and possibly themselves, in serious legal and
financial jeopardy, according to faculty members at Wharton and
at the University of Chicago's Graduate School of Business. (Read
more...)

This paper
highlights recent changes to the consequences of fraudulent conduct
in the corporate accounting and securities industries. Following
the Enron and Worldcom scandals, the Sarbanes–Oxley Act of 2002 has
increased the penalties for fraudulent and misleading conduct. All
corporate periodic reports must be personally certified by the CEOs
and CFOs, who must state that the reports present fairly, in all
material respects, the financial conditions and results of
operation of the issuer, under penalty of up to ten years'
imprisonment and/or a fine of up to US$1m. The Act establishes a
system of full disclosure of company finances and of company
internal controls, including methods of calculation used in
reports. Materiality is defined from the investor's point of view.
The paper also explains the Act's effects on public accounting
firms, senior employees, former employees, 'whistleblowers',
employees who destroy documents or evidence, misleading accounting
practices which artificially inflate the company's financials, the
general accounting principles and corporate lawyers. Although some
of the changes have been watered down by the SEC's implementing
regulations, the effect of the Act is still dramatic and is
designed to boost investor confidence in the system. (Read
more...)

2003: TheCPAs Handbook of Fraud and Commercial Crime Prevention
describes the results of an academic study based on companies
identified by the Securities and Exchange Commission (SEC) as
earnings manipulators during a 10-year period. The study was
conducted by Messod D. Beneish, an associate professor at the
Kelley School of Business, Indiana University. The results were
published in "The Detection of Earnings Manipulation,"
Financial Analysis Journal 24 (1999); 24-36.

The purpose
of the study was to develop quantitative fraud warning signs by
analyzing a series of ratios that might be used as predictors of
material misstatements caused by fraud. The research identified a
group of financial statement variables that may be helpful in
identifying material misstatements caused by fraud. These
variables are: (Read
more...)

By far, the most common accounts manipulated when perpetrating financial
statement fraud are revenues and/or accounts receivable; the COSO-sponsored
study found that over half of all financial statement frauds involved
revenues and/or accounts receivable accounts. The COSO study also found that
recording fictitious revenues was the most common way to manipulate revenue
accounts, and that recording revenues prematurely was the second most common
type of revenue-related financial statement fraud. Other studies have found
similar results. (Read
more...)

DECEMBER 2002: Management fraud is unstoppable
because no controls, past or present, exist to completely control
management's actions. Management controls internal control, and can
generally do as it pleases, including overriding controls whenever they
prevent management from attaining its objectives. (Read
more...)

OCTOBER 2002: Assessing an organization's conditions, corporate structure, and the
choices it makes can help reveal the motivations, opportunities, and
rationalizations behind the commission of financial statement fraud. (Read
more...)

APRIL 2002: Most of us don't make loans to the Enrons of the world, but in the wake of
the largest bankruptcy in U.s. history, what can we learn to protect
ourselves and our banks? Actually, quite a lot, because many of the factors
that led to the Enron debacle are common among companies of all sizes.
Although there are many more, here is a short list of things to watch for
that aren't related to the size of the company. (Read
more...)

APRIL 2002: Readers of Russian newspapers were not at all
surprised by recent stories about Enron. During the ’90s, Russian energy
companies were notorious for cooking their books, defrauding their
shareholders and using political connections to cover shadowy deals. (Read
more...)

APRIL 2002:
So I'd like to begin my remarks to you
tonight with a story about the sea. Specifically, about a captain
who is sailing his ship through rough seas at night. In the
distance he sees the flashing light of another ship, which is
approaching pretty fast.

MARCH 2002: Only
months before Enron Corp.’s bankruptcy filing in December 2001, the firm was
widely regarded as one of the most innovative, fastest growing, and best
managed businesses in the United States. With the swift collapse,
shareholders, including thousands of Enron workers who held company stock in
their 401(k) retirement accounts, lost tens of billions of dollars.

Investigations of
wrongdoing may take years to conclude, but Enron’s failure already raises
financial oversight issues with wider applications. Why didn’t the watchdogs
bark? This report briefly examines the accounting system that failed to
provide a clear picture of the firm’s true condition, the independent
auditors and board members who were unwilling to challenge Enron’s
management, the Wall Street stock analysts and bond raters who missed the
trouble ahead, the rules governing employer stock in company pension plans,
and the unregulated energy derivatives trading that was the core of Enron’s
business. (Read
more...)

FEBRUARY 2002:
There is increasing international concern about the escalation in
fraudulent financial statement reporting and the difficulties in
detecting and proving such fraud.

A major obstacle
to addressing the problem of financial statement fraud promptly, is
related to the difficulty of identifying the fraud soon after its
occurrence. Because it is often a management fraud, it is well
hidden from auditors, investors and other stakeholders and it is
usually only discovered by chance or once the company is in
financial difficulty, which may result in a takeover or insolvency.
It is therefore important to attempt to manage the risk of fraud by
using early warning signals such as ‘red flags’. (Read
more...)

JUNE 2001: To stay
ahead of financial statement fraud, fraud examiners must step
up to a new level of analytical comprehension and intellect to
uncover the latest devious techniques.

Financial
statement fraud is "a new kid on the block," and the intent to conceal and
take advantage by false suppression of the truth of assets, liabilities,
cash flow, sales and profitability is creating a new level of risk for
corporate America. Fraud examiners must have a new level of analytical
comprehension and intellect to uncover the devious techniques. (Read
more...)

MAY 2001: When companies get desperate to show earnings or reduce
losses, sometimes they resort to fraudulent timing differences to show phony
profits. By recognizing these often simple schemes CPAs can usually detect
material financial statement frauds early, before they become catastrophic.
(Read
more...)

Why the CEO goes bad

MARCH 2001: As CPAs it is important to
understand both the methods and motivations at play when otherwise ethical
executives participate in fraudulent financial statement schemes. According
to a 1999 study by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), in three-quarters of fraud cases the chief executive
officer is directly involved. So try to trade places—in your mind—with the
CEO of any public company. Imagine:

The market analysts have been pestering you,
the CEO of the company, and your brother, the CFO, for advance information
on the upcoming quarterly earnings announcement. They are predicting your
company will earn 75 cents per share, just as in the last 9 quarters. But
you know something they don't: The company will be lucky to earn half that
amount. Because the product recently introduced isn't selling well, profits
are going to take a big hit. When that happens, the stock price is bound to
tumble. You wouldn't and couldn't tell the analysts this terrible news.

You've always considered yourself honest and
ethical. Everyone in the company looks up to and admires you. Ironically, if
the real truth about the earnings becomes public knowledge, many of the
people who think so well of you will likely lose their jobs. You could go,
too. And all of this is your fault. You believed in the new product line so
much that you gambled the company's whole future on it.

What do you do? The choice seems obvious. The
lesser of two evils would be to fix the numbers before the quarterly report
goes out. "Good grief, this is terrible," you think to yourself. "But if we
can just get past this quarter." (Read
more...)

DECEMBER 2000: Detecting
financial fraud is difficult, even for the best auditors. To
arm auditors with the tools to detect and prevent fraud, a
study by the Committee of Sponsoring Organizations (COSO) has
identified six key areas:

Types of companies engaged in fraud and
employees involved;

Nature of the frauds;

Ineffective audit committees and board
governance;

Industry-specific traits;

Incentives for fraud due to ownership,
financial condition, and market expectations; and

SEPTEMBER 2000: Take your pick of fraudulent financial reporting
schemes. One of these gimmicks, manipulating reported income
through “earnings management” techniques, draws its share of
attention in the financial press. A company can effect earnings
management practices in a variety of ways. One of the most popular
vehicles for earnings management, however, stems from a misuse or
misunderstanding of the proper application of materiality, a
concept central to the preparation and audit of all financial
statements. (Read
more...)

JANUARY 2000:
Have you heard the one about the company that needed to hire a
chief corporate accountant? In the last interview session each
finalist was given financial information and asked, "What are the
net earnings?" All applicants but one dutifully computed the net
earnings but none of them got the job. The candidate who landed the
position answered the question by replying, "What do you want your
net earnings to be?" (Read
more...)

The forms and faces of financial statement fraud are many, various--and
often disastrous.

DECEMBER
1999: STEVE
MCMILLAN, GENERAL Auditor for a medium-sized financial services holding
company, had recently joined the organization after an eight-year career in
public accounting. He and Karen Johnson, one of the company's audit
managers, were discussing a meeting they had had with the CEO earlier that
day.

The CEO had
begun the meeting by acknowledging that most internal auditors are not
usually concerned about fraudulent financial reporting. "However, I'm taking
this issue seriously," he continued. "I want to be sure that this company
cannot be accused of managing earnings or fraudulent financial reporting of
any kind." (Read
more...)

OCTOBER
1999: EC Chairman Arthur Levitt decried what he termed "accounting
hocus-pocus" and called for coordinated efforts to uncover it. He targeted
the practice by some companies of improperly boosting reported earnings by
manipulating the recognition of revenue. Among the most common methods of
doing this are the bill-and-hold transaction and a long list of sham
transactions involving shipping, billing and/or related-party involvements.
Both the SEC and the AICPA seek to increase independent auditors' awareness
of problems associated with these practices.

Public
companies feel pressure to report quarterly earnings that meet or exceed
analysts' expectations—after all, failure to meet those expectations can
hurt companies' stock prices. This pressure can lead to practices that
sometimes include fraudulent overstatement of quarterly revenue. Any of the
improper and unusual revenue-transaction methods used to misstate quarterly
revenue also can be used to change annual results. Auditors need to be alert
to the whole gamut of warning signs that revenue-recognition fraud may be
present. (Read
more...)

Fraudulent
financial reporting can have significant consequences for the organization
and for public confidence in capital markets. Periodic high profile cases of
fraudulent financial reporting raise concerns about the credibility of the
U.S. financial reporting process and call into question the roles of
auditors, regulators, and analysts in financial reporting. (Read
more...)

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